Since the company reported its Q3 earnings in November, Nvidia (NASDAQ:NVDA) has been on a tear with Nvidia stock adding more than 15%. And this is after an increase of over 80% since its June 2019 trough. Nvidia has turned around.
Part of the reason is that the company reported stellar results for Q3. Another reason is that in Q4 Nvidia expects even better results.
When I last wrote about Nvidia stock, I pointed out that the company’s gross margins had been rising along with revenue. Moreover, Nvidia was predicting gross margins for Q3 would be 62.5, plus or minus 0.5%. This was up from 60% from the prior quarter.
Nvidia did much better than it predicted. Its Q3 gross margins were 63.6% on a GAAP basis. On a non-GAAP basis, they were 64.1%. So, in a sense, it outperformed its prior expectations.
The biggest difference between the two measures is that stock-based compensation expenses (“SBC”) are added back to non-GAAP figures. This assumes that the options and stock that employees receive are not cash or recurring expenses. Non-GAAP margins also include legal settlements, which are also considered non-recurring or material.
Nvidia’s outlook for Q4 is 64.1% for GAAP gross margins and 64.5% for non-GAAP gross margins. These are significantly higher than the predicted and actual Q3 gross margins.
Moreover, the fact that Nvidia appears to be conservative in its outlook. This helps investors in their consideration of Nvidia stock’s value. In fact, as I pointed out, Nvidia stock has subsequently risen over 15%.
A Closer Look at NVDA Year-over-Year
It is true that net income was lower than year-over-year earnings in Q3. The Wall Street Journal said this was “the fourth straight quarter of lower earnings.”
The truth is that the sequential earnings in Q3 were higher than Q2. This is along with the higher gross margins.
In fact, as you can see in the chart I have prepared above, the sequential revenue by quarterly has been rising for the past four quarters. This is despite the fact that year-over-year sales are lower. The Q4 estimate is from the upper end of the range that Nvidia provided in its outlook for Q4.
This chart helps explain why Nvidia stock has been rising. The sequential revenues have been rising.
Other reasons are the fact that, as the Wall Street Journal pointed out, revenue linked to its cloud-based computing activities was higher during the third quarter.
This was also the case with its gaming-related revenue, which makes up more than half of total sales.
Nvidia and High Valuation
Despite the ever-increasing revenue for the past four quarters, and the higher quality of revenue, Nvidia stock has reached something of a peak.
This can be seen in the value metrics. It trades at an EV-to-Sales ratio for its next fiscal year at 11.8 times. This is based on a forecast for Q4 sales going forward and increasing it by 2.5%.
In addition, its price-to-earnings ratio, based on Seeking Alpha estimates, is 45 times for this year and 35 times for the coming year.
By contrast, some of Nvidia stock’s peers are much cheaper. For example, Advanced Micro Devices (NASDAQ:AMD) trades for 8.6 times price-to-sales for 2019 and 9.3 times on an EV-to-Sales basis, according to Yahoo! Finance. The ratios for its 2020 estimates are undoubtedly lower.
Another example is Micron Technologies (NASDAQ:MU). Its forward price-to-sales ratio is 2.6 times and its forward EV-to-Sales ratio is 6.6 times.
Moreover, MU stock’s price-to-earnings forward ratio is 10.1 times, according to Yahoo! Finance.
So the point that you can see is that Nvidia stock is much higher in its valuation metrics than its peers.
What Should Investors in Nvidia Stock Do?
Nvidia is expected to report its earnings by Feb. 11, 2020. Recently a UBS analyst, Timothy Arcuri, maintained his Buy rating on Nvidia stock.
His target for Nvidia is $300 per share, up $60 from today’s price, or 25%. That is a pretty serious recommendation. So far, he has been right.
For example, he previously predicted in November 2o19 that Nvidia would reach $240, which it now has. Like the old Wall Street saying goes, “Don’t fight the tape.”
But I still insist that value investors should take notice of the sky-high valuation that these price targets imply. Long-term, defensive investors will likely look for an opportunity to jump in during a downturn.
As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities. Mark Hake runs the Total Yield Value Guide which you can review here. The Guide focuses on high total yield value stocks. Subscribers a two-week free trial.
